S&P Global Ratings said its outlook on the U.K. banking sector is negative as banks' road to recovery will be a tumultuous one amid a new variant of the COVID-19 virus, renewed lockdown restrictions and dwindling fiscal and monetary support from the state.
Ratings may revise the outlook on the sector or certain banks if less uncertainty around the recovery trajectory reduces, and it has more confidence about society's ability to manage the pandemic while restoring economic activity and the asset quality implications of lower fiscal support compared to a year ago. But the agency is unlikely to change the negative outlook on the U.K. Banking Industry Country Risk Assessment, or BICRA in the near term, due to the "competing pulls" of the current lockdown and the vaccination program.
Dwindling support
The agency said higher impairment provisions British banks booked in 2020, along with their capital resources, will help them get through the current credit cycle but impairment charges will likely remain above historical trends. Lockdown restrictions are likely to remain in place until the vaccination program reaches critical mass and stimulus packages will start to dwindle, while borrower defaults are expected to increase along with charge-offs, all of which creates more uncertainty around the scale of ultimate losses.
Significant fiscal and monetary intervention has supported banks' asset quality so far and kept bankruptcies and unemployment below the levels such an economic downturn would usually result in, and it has delayed an expected increase in stage 3 loans. As the government manages down its fiscal support the agency expects unemployment to peak at over 7% after the U.K. winds down its furlough scheme in April.
Meanwhile, impairment charges for the fourth quarter are expected to exceed the previous quarter due to the renewed lockdown restrictions and more rigorous year-end credit review processes. U.K. banks have a higher level of stage 2 loans than international peers, partly due to how they adopted International Financial Reporting Standards 9, or IFRS 9, but almost all stage 2 loans are performing for now. The agency expects past-due stage 2 loans and stage 3 loans to rise as government intervention dwindles.
Loan schemes and moratoria
The agency does not expect loan moratoria to affect banks' asset quality since most agreements were made as a precautionary measure and have ended. New payment holidays amid the new restrictions are unlikely to have an effect since customers who have already benefited from a full payment holiday are ineligible for another one.
According to industry data, mortgage deferrals peaked at 1.8 million in June 2020 and declined to 127,000 by mid-November 2020. 89% of customers have already resumed payments. Meanwhile, British banks have completed £68.2 billion of corporate loans under COVID-19 government-guaranteed schemes, including £43.5 billion of 100% guaranteed bounce back loans to small- and midsize-enterprises, with the residual amount 80% guaranteed.
2021 earnings
Operating costs and credit loss charges are expected to improve in 2021 compared to the previous year as banks prioritize cost efficiency and the shape of the economic recovery becomes less uncertain.